Crying Wolf: Warnings about oil supply

"[Vannevar Bush] never flatly refused to satisfy a politician's curiosity,
but rather dared him to comprehend the technical and military issues. Most
politicos wisely kept their mouths shut."
From a review of "Endless Frontier" by G. Pascal Zachary, Wall Street Journal, 10/21/97, A20.

In the past two years, a number of articles have appeared warning not
only of a new oil crisis, but of the end of the oil era, as oil production
inevitably peaks and declines due to inexorable geological forces. These
include "Mideast Oil Forever?" by Joseph J. Romm and Charles B. Curtis
and "Heading Off the Permanent Oil Crisis," by James J. MacKenzie, among
others.

The profusion of articles on the subject is unfortunate, since the casual
reader (and policy-maker) might conclude that the large number of articles
have an equally large amount of research behind them. In truth, most of
these are not actually about oil, but take the assumption that oil scarcity
is imminent, especially outside the Middle East, and nearly all rely on
a few pessimistic quotes from oil men, or recent work by one or two geologists
using what is known as a "Hubbert approach." Most notable are the recent
publication of the book The Coming Oil Crisis by Colin Campbell and the
March 1998 Scientific American article "The End of Cheap Oil" by Colin
J. Campbell and Jean H. Laherrere.

The gist of their argument is that most of the world's oil has already
been found, as evidenced by the alleged lack of recent giant discoveries;
Middle East reserves have been overstated for political reasons; actual
total recoverable resources are only about 1.8 trillion barrels, not the
2.4 trillion barrels that others have estimated; existing fields will not
continue to expand in size and production as others suggest; and most oil
producing countries outside the Middle East are said to be near, if not
past, their point of peak production, which occurs when 50% of total oil
resources have been produced. Production is predicted to drop off steeply
afterwards. Thus, they forecast that "The End of Cheap Oil" is at hand
and prices will be rising shortly.

Understanding Forecasts (Good and Bad)

These issues are hugely complex. A wide variety of political, economic
and geological factors affect oil production, and analysis requires an
enormous amount of data, much of which is either not readily available
or is unreliable. Few observers have the capacity to analyze the forecasts
of others, let alone make their own forecasts. Thus, as Vannevar Bush realized,
when an expert, particularly with a scientific background, comes forward
with detailed work and large quantities of (albeit hidden) data, it gains
almost instant respectability, particularly among editors who are not familiar
with the subject.

But there are several methods of judging research that don't involve
time-consuming or labor-intensive analysis. For one thing, analysts who
don't acknowledge either data or research which contradicts their theories
are implying they can't explain inconsistencies or weakness in their work.
Because in a complex system like world oil production, there is always
some data which can support alternative viewpoints. Dry holes are always
being drilled and new fields are always being found, and citing one or
the other to support pessimism or optimism proves nothing.

A better way to test forecast validity is to look at the historical
record, and particularly, examine work done by the person making the forecast
in question. In 1992, I did precisely this to improve long-term oil price
forecasting. The realization that the previous errors were due to forecasters
assuming a 3% per year increase in real oil prices over the long-term made
it possible to produce much more accurate forecasts.

In 1996, I published a piece discussing the various methods which were
used to forecast oil supply, and argued that they, too, were flawed by
certain repetitive errors, namely: 1) bias, and especially pessimism, since
nearly every forecast has been too low since 1978, despite relying on price
assumptions that were much too high; 2) similar forecasts for every region,
despite different fiscal systems, drilling levels and/or the maturity of
the industry, suggesting omitted variables; 3) misinterpretation of recoverable
resources as total resources by using a point estimate instead of a dynamic
variable, growing with technology change, infrastructure improvements,
etc.; so that 4) there is a tendency for all national, regional or non-OPEC
production forecasts to show a near-term peak and decline, which was always
moved outward and higher in later forecasts (the opposite of price forecasts).

As an example, note the behavior of the U.S. Department of Energy's
production forecasts for the non-OPEC Third World, a region which, in aggregate,
has experienced very little drilling and shows no sign of peaking, causing
the forecasts to be repeatedly revised upwards. (Figure
1) I have numerous other such examples, for various countries and regions,
as well as the globe. Few, if any, have been too optimistic.

The Case in Question: Campbell

Thus, an examination of the history of forecasts performed by these
gentlemen is in order. First, the company Petroconsultants, which both
men have been associated with in the past and which published Campbell's
1997 book, published a nearly identical forecast in 1986, which showed
regional production to 1995, at $25/barrel (equal to about $35/bbl in 1997$).
The forecast incorrectly put non-OPEC, non-Communist production at 20 mb/d
in 1995 and dropping, when in reality it was 28 mb/d and rising. (Figure
2) Figure 3 shows the regional forecasts, normalized to 1986=100 to
show the rates of change. Note that all regions peak within the time horizon
of the forecast. It is not clear if either Campbell of Laherrere was involved
in producing this forecast, however, they are employing the same database
of oil fields, and their results are suspiciously similar.

Subsequently, Campbell published an article in the December 1989 Noroil
which stated that"Most economic forecasts see relatively stable prices over the near
future followed by a ramp of modest increase to the end of the century.
But Figure
3 suggests that the slope of declining supply will become a precipice
if production is held at present levels, never mind increasing. When that
happens, a major leap in prices seems inevitable unless the major exporting
governments exercise deliberate restraint....Shortages seem to be inevitable
by the late 1990s, but knowledge of an impending supply shortfall may trigger
an earlier price response, as foreseen in the Figure." His
figure shows world oil production (including the Middle East) peaking in
the late 1980s, and dropping sharply, from about 58 mb/d to 45 mb/d, with
the comment that "Any short-term increase steepens subsequent decline."
He also shows prices rising to the low $20s (about $27 in 1997$) as "increasing
probability" with an "anticipated price leap from increased perception
of declining reserves, falling non-Middle East production, and falling
exports, esp. from USSR." He predicted this might cause oil prices to reach
$50/bbl (about $65 in 1997$) by 1994, then fluctuate around that level
to the end of the century.

That same year, my Oil Prices to 2000 was published, taking the contrary
view. I argued that most forecasts were too pessimistic about non-OPEC
production and predicted that inflation-adjusted prices would fall to 2000,
which the September 1989 Petroleum Economist correctly noted was "heretical".
Yet this proved quite accurate, as a comparison of forecasts from that
period shows (Figure
4) . (Later figures will compare production forecasts.) Since Campbell
(1989) includes only a graph of his price forecast, it is not shown here,
but by the mid-1990s, he showed prices fluctuating around $50/bbl, about
200% too high.

The 1991 Forecast: Deja vu all over again?

Campbell's 1991 book is more illuminating, and damning, since he provides
detailed production tables for most countries, including 32 non-Middle
East, non-FSU producing countries which account for 36.8 mb/d in 1996.
The aggregate error by 1996 is 7.9 mb/d, or 21.5% of production in those
countries, as Table
1 shows. Twenty-four of the forecasts are too low, and eight are too
high. An examination of the particular countries' errors is instructive
about their nature.

For example, except for Italy, Tunisia and Oman, in all of the countries
where Campbell's forecast is too high, the upstream sector is controlled
by national oil companies. This shows the importance of policy and economics,
refuting the argument that geology alone determines long-term production
profiles. If Campbell is said to be projecting possible, not actual production,
so that his error on these countries should be disregarded, then it leaves
a total "optimistic" error of only 106 tb/d, a trivial amount. This demonstrates
clearly that his method is biased in a scientific sense, always producing
forecasts which will tend to be too low.

Additionally, the enormous error in countries like Canada and the United
States, Figures
5 and Figure
6 , indicates the inability of this measure to produce accurate results.
He argues that these are mature producing areas, where no more giants are
to be found and cause surprise increases in oil production, and the oil
field database he employs corrects for the conservative bias due to SEC
reserve reporting requirements. Since the oil resources are thus so well-known,
the production curve should be extremely accurate. Yet even without any
giant field discoveries, both countries have outperformed his forecast
far beyond levels conceivable to him. If this method doesn't work in mature
regions with high-quality data, it is hardly likely to be reliable elsewhere.

Similarly, the enormous predictive failure in the North Sea (
Figures 7 and Figure
8 ) shows that extrapolation of discovery size does not produce accurate
predictions of either future field size or resource estimates, since the
error should be due more to underestimating new discoveries than pessimism
about the role of older fields, as is the case for the U.S.

Finally, considering individual countries in the Third World, his method
seems to always generate a bell curve with imminent peaks for everyone
outside the Middle East. Examples include Argentina, Egypt and Malaysia
(
Figures 9 , Figure
10 and Figure
11 ). As Table 1 showed, he was repeatedly too low for Third World
producers, especially those with relatively open upstream investment.

In fact, what is remarkable is the similarity between Campbell's 1989,
1991 and 1997/98 forecasts (if one ignores the dates). Always, the peak
is imminent. But this precisely conforms to the argument in Lynch (1996),
namely that this method almost always produces a near-term peak, no matter
when or where it is applied, and thus constantly needs to be revised upwards.

Broader Comparison

It might be thought that Campbell has simply reproduced the poor forecasts
so often seen in the oil industry, but his errors are larger than most.
As a test of the validity of my own 1989 forecast, I had earlier assembled
other forecasts from that period for comparison, and to these I add Campbell's
projections. The fact that his work was done two years later than the others
(although EMF11 was also 1991), should provide him with an advantage, since
he has two more years of data to observe and any inherent errors in his
work will have less of an impact because of the shorter test period. Again,
the forecasts are all normalized to common starting points, and some points
are interpolated.

In Figure
12 , the forecasts for non-OPEC, non-FSU are shown, and Campbell's
is clearly the worst of the lot. The same is true for OECD oil production
(
Figure
13 ), although for non-OPEC Third World, his inability to predict the
impact of state-owned companies' lower exploration levels leaves him in
the middle of the forecast group, at least to 1996 (
Figure
14 ). Clearly, this method does not produce accurate results.

1997/98: Deja Vu All Over Again Again

In 1997 and 1998, C. J. Campbell published a book and two Oil and Gas Journal
articles which argued that the price of oil is about to increase, since
most major oil producing nations outside the Middle East are reaching their
depletion midpoints, after which production will decline, and decline sharply.
Essentially this is the same argument from his 1989 and 1991 work, namely
that oil production will imminently peak in all major countries outside
the Middle East and global production cannot go much higher than the present
amount. Since he is clearly using precisely the same methodology, and does
not explain the failure of his earlier predictions, it appears that all
he has done is update his data, increase his resource estimates and production
forecasts, and move his production peaks higher and further out, exactly
as Lynch (1996) contended would be necessary with this method.

Specifically, he increased his estimate of global oil resources from 1650
billion barrels to 1800 billion barrels, close to the amount of oil produced
during that period. The 1997 book contains only a few regional tables,
so his predictions for individual nations cannot be analyzed. However,
the world total is published, and as Figure
15 shows, it has increased dramatically from the 1991 publication.
Also, W. Europe and the U.S. were published in his 1997 book, and they
too show the same pattern of increasing. (
Figures 16 and Figure
17 )

In his 12/29/97 OGJ article, he did present a number of small graphs
showing bell curves for a variety of countries, some which he described
as being past their depletion midpoint, some of which had not yet reached
it. These are shown in Table
2 , along with the depletion midpoint which he gave in his 1991 book,
and they reaffirm my earlier arguments. The fact that all of these countries
are predicted to peak by 2001 implies that there is a pessimistic bias
(#1 and 2 from Lynch 1996 above). And his having to move the depletion
midpoint out an average of 4 years for the countries which haven't peaked
supports the argument (#4 from Lynch 1996 above) that this method always
requires correction, and that the peak constantly needs to be revised to
a higher, later level.

Conclusion

If Campbell's estimation methods produce accurate, rather than conservative,
resource estimates, overcoming the objections about field and resource
growth made by Adelman and Lynch, and if the Petroconsultants field size
estimates are accurate because they don't have to conform to SEC rules
requiring conservative field size reporting, why have his production forecasts
been much too low and why have his resource estimates increased?

Lynch (1996) argued that the Hubbert method fails because it takes
recoverable (not total) resources as fixed, and assumes that to be the
area under the curve of total production. When the estimate of the area
under the curve (resources) is increased, the entire increase must be applied
to future production. This is exactly what is happening with Campbell,
as Figure 15 shows. The errors in his 1991 forecast and the adjustments
he has made in his latest work are thus predicted by Lynch (1996). Campbell
has not provided an alternative explanation, merely ignored them. And as
Figure
18 shows, his forecast is well outside the mainstream.

Short-term prices will certainly fluctuate, and we will surely have
more oil crises, since they are short-term events. Unfortunately, there
is little doubt that the certain failure of the current Cassandras will
be forgotten within a few years and a new round of alarms will be sounded.
Hopefully, it will not receive the attention that the current (and previous)
ones did, and even more hopefully, most governments and companies have
already learned their lesson from the tens of billions of dollars wasted
when others cried wolf during the 1970s.